cima - p2 final assessment - answers m14

CIMA

Paper P2

Performance Management May 2014

Final Assessment Answers

To gain maximum benefit, do not refer to these answers until you have completed the final assessment questions and submitted them for marking.

CIMA P2 PERFORMANCE MANAGEMENT

2 KAPLAN PUBLISHING

Kaplan Financial Limited, 2013

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The text in this material and any others made available by any Kaplan Group company does not amount to advice on a particular matter and should not be taken as such. No reliance should be placed on the content as the basis for any investment or other decision or in connection with any advice given to third parties. Please consult your appropriate professional adviser as necessary. Kaplan Publishing Limited and all other Kaplan group companies expressly disclaim all liability to any person in respect of any losses or other claims, whether direct, indirect, incidental, consequential or otherwise arising in relation to the use of such materials.

FINAL ASSESSMENT ANSWERS

KAPLAN PUBLISHING 3

SECTION A

1 BATCH PRODUCTION

(a) y = axb

y = 15 400.3219

y = 4.575 hours

Total time for 40 batches = 40 4.575 hours = 183 hours

(b) y = axb

y = 15 390.3219

y = 4.612 hours

Total time for 39 batches = 39 4.612 hours = 179.868 hours

Time for 40th batch = 3.132 hours

Time for batches 41 60 = 20 3.132 hours = 62.64 hours

Time for the first 60 batches = 183 hours + 62.64 hours = 245.64 hours

(c) The new employees will not have had any benefits of learning so they may initially take around 15 hours to complete a batch. Furthermore the experienced workers may be slowed down by working with less experienced workers so that their time per batch is likely to increase above 3.132 hours. The rate of learning of the new employees may be faster than 80% as the experienced workers will be able to pass on their learning to the new employees.

Marking scheme

Marks (a) Right formula Y = 15 40 0.3219 Total time for 140 batches

1 1

(b) Total time for 39 batches Time for 40th batch Time for batches 41 60 Total time for all first 60 batches (c) New employees adverse impact on efficiency (lack of training) Current employees affected by new employees All other valid comments 1 mark each, maximum 2

1 1 1 1 1 1 2

Total 10


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2 PTG LTD

(a) (i) Level of sales required from product B to make the company overall breakeven:

Company will breakeven when:

Total contribution = Total fixed costs

i.e. when total contribution = $7,000,000 + $600,000

i.e. when total contribution = $7,600,000

Current total contribution for A = $6,000,000. After the introduction of B, As contribution becomes $6,000,000 (120%) = $4,800,000.

So in order to break even, we need Bs total contribution to reach $7,600,000 $4,800,000 = $2,800,000.

Level of sales required from B = ratiosalestooncontributisB'

$2,800,000

Level of sales required from B = )000,000,8$000,000,6($

000,800,2$

Level of sales required from B = 75.0

000,800,2$

Level of sales required from B = $3,733,333.

(ii) To achieve a profit of $1m, we need

Total contribution = Total fixed costs + $1,000,000

Total contribution = $7,600,000 + $1,000,000

Total contribution = $8,600,000

After the introduction of B, As contribution becomes $6,000,000 (120%) = $4,800,000.

So in order to achieve $1m profits, we need Bs total contribution to reach $8,600,000 $4,800,000 = $3,800,000.

Level of sales required from B = 75.0

000,800,3$

Level of sales required from B = $5,066,667.

(iii) Margin of safety (%)

= activityoflevelBudgetedactivityoflevelbreakevenactivityoflevelBudgeted

100%

Margin of safety (%) = 000,000,8$

333,733,3$000,000,8$ 100%

Margin of safety (%) = 53.33 %


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(b) A fixed budget (or static budget) is based on a single level of activity (e.g., a particular volume of sales or production). Actual results are compared against budgeted (standard) costs only at the original budget activity level. Fixed budgets are useful as they include all standard costs and revenues to be used as a basis for performance management at the end of the accounting period.

A flexible budget differs from a static budget because it is not geared to only one activity level, but rather, toward a range of activity. They are useful for both planning and control purposes:

Planning: When preparing a flexible budget, managers are forced to consider the different scenarios and their responses to them. Thus for a number of different situations, manager swill have calculated their costs and revenues. If an unexpected event does occur, changing the level of activity, management will be better prepared.

Control: Where the actual level of activity is different to that expected, comparisons of actual results against a fixed budget can give misleading results. A flexible budget is useful because it adjusts the fixed budget for the actual level of output.

Marking scheme Marks (a) (i) Total contribution $7.6m

Total contribution for A after introducing B $4.8m Bs total contribution $2.8 m Bs contribution to sales ratio 0.75 Level of sales required from B (ii) Level of Bs sales to achieve required profits (iii) Margin of safety

0.5 0.5 0.5 0.5 1 1 1

(b) Definition of fixed budget Definition of flexible budget Usefulness of fixed budget Usefulness of flexible budget planning & control

1 1 1 2

Total 10

3 UNCONTROLLABLE

Tutorial note

Be prepared for these questions with no scenario attached and brief requirements; they have appeared more frequently in Section A of the CIMA P2 exam recently.

(a) An uncontrollable cost is a cost that cannot be influenced by the actions of a specific responsibility centre manager. There is a strong argument for not charging uncontrollable costs to responsibility centres because managers might be demotivated by being held responsible for costs over which they have no control.


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However there are arguments in favour of charging uncontrollable costs, which are usually central overhead costs, to responsibility centres, three of which are as follows.

(i) Responsibility centre managers are made aware of the significance of other or central overhead costs and are less likely to see the relevant services as free and thus over-use them.

(ii) Profit and investment centre managers are made aware that they need to earn a sufficient profit to cover a fair share of other overhead costs.

(iii) If managers are aware of central and other overhead costs and feel they are being held partly responsible for them, they may put pressure on the centres incurring the costs to encourage them to keep the costs to a minimum or provide the services more efficiently.

(b) Feedforward control is the comparison of planned outcomes with the actual outcomes that are projected to occur in the future and the taking of action before the event to avoid any identified differences.

In contrast, feedback control is based on a comparison of historical actual results with the budget for the period to date, and taking action to correct such differences, either to bring performance back into line with budget, or to revise the budget for the forthcoming period.

The key advantage of the use of feedforward control is that it is forward looking. It informs management about what is likely to happen unless control action is taken now. Management can compare their targets for the period with current expectations and be forewarned of likely differences.

A problem with feedforward control is that control reports should be produced regularly, which means that it is necessary to update forecasts regularly. While this may be a desirable thing it can be time consuming and relies on the availability of efficient forecasting models.

Marking scheme Marks (a) Every valid comment worth 1 mark; only award full 5 marks if THREE different arguments are mentioned.

5

(b) Contrast feedforward with feedback comments, 1 mark each if valid, maximum 2 Feedforward advantages comments, 1 mark each if valid, maximum 2 Potential problem

2

2 1

Total 10


KAPLAN PUBLISHING 7

4 EVANS LTD

To: The Managing Director From: The Management Accountant

Date: 23 May 2007 Subject: Life cycle costing

Introduction

This report details the main features and objectives in a life cycle costing (LCC) environment. It then considers how LCC may be of benefit to Evans Ltd.

Principles of life cycle costing

LCC accumulates all costs and revenues over the entire life cycle of a product from its inception to abandonment. The objective is to try and maximise benefit over this entire life cycle. As a result of this idea all research, development, design and marketing costs are specifically traced to products as well as the more usual production and distribution costs.

Three main goals must be achieved in a LCC environment:

Design costs out of the product

As a result of LCC companies have become aware that 80 90% of a products costs become locked-in or committed at the design stage. Long term manufacturing costs become established before the product is actually launched. Thus it is essential to design the product with a cost conscious manner. This will often lead to simple design features with the minimum number of parts and standard parts being used across many product lines.

Minimise time to the market

Having designed a new cutting edge product that will potentially be the best on the market, it is essential to get the product to the customers as quickly as possible. It is important to dominate the market and be ahead of the competition for as long as possible.

Maximise the length of life of the product

Generally the longer the life cycle the greater the profit that will be generated, assuming that production ceases once the product goes into decline and becomes unprofitable. One way to maximise the life cycle is to get the product to market as quickly. Another way of extending a products life is to find other uses, or markets, for the product. Other product uses may not be obvious when the product is still in its planning stage and need to be planned and managed later on. On the other hand, it may be possible to plan for a staggered entry into different markets at the planning stage.

Benefits to Evans Ltd

There are potentially several benefits that may be gained by Evans Ltd adopting LCC.

These include:

1 A greater understanding of research and development costs. With a wide range of products and rapidly changing technology Evans Ltd has significant R and D expenditure. Being able to accurately charge these costs to individual products will provide Evans Ltd with more accurate information allowing them to make better decisions. For example, pricing decisions based upon costs may be better.


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2 Reduction in manufacturing costs. Once Evans starts actively designing costs out of their products unit manufacturing costs should decrease.

3 Minimising time to the market will keep Evans Ltd as the leading manufacturer of the TV components. As the moment Evans is the sole supplier to two large companies, in order to maintain this privileged position it must satisfy their demand for new components quickly. They must deliver their service faster than any competitors could.

4 The technology in digital TVs is advancing rapidly and the component range must be continually updated. By adopting LCC Evans Ltd may be able to adapt or upgrade existing components rather than starting afresh in the R and D department. By doing this Evans will be maximising the length of life of its products.

5 Evans Ltd could perhaps start investigating new markets are there any other TV manufacturers that may desire Evans products?

Conclusion

The report shows clearly that there are potential savings and rewards to be gained in both the short and the long term by introducing LCC to Evans Ltd.

If you require any further assistance with this matter then please do not hesitate to contact me.

Signed: Management Accountant

Marking scheme Marks Format of report (must include introduction and conclusion) 2 Charging of costs/revs over entire life cycle 1 Three main principles 3 Benefits to Evans Ltd 4 Total 10

5 AB COMPANY

(a) Opportunity cost may be defined as the best opportunity foregone by pursuing a given course of action. It can only apply when the resource being considered is scarce.

In this example there are 50 kgs of material X available in inventory and 100 kgs are required. So there may be an opportunity cost if there is more than one use for the material. There are two options for the material X in inventory, scrap at a value of $2 per kg or use as a replacement for material Y, which would save $6 per kg. The latter is the preferable option and so would be chosen. The net benefit to the company would be $4 per kg, equivalent to the $6 saving less an opportunity cost of $2 per kg, which is the value of the next best alternative.

(b) In accept/reject decisions, opportunity costs avoid the rejection of a contract on the grounds that a net loss would result where conventional matching of costs and revenues is applied. It recognises the sunk or unavoidable nature of many costs in the short-term.


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For example, the original cost of the material is irrelevant if the best alternative to using it on the contract is to sell it as scrap. There may even be a negative opportunity cost if by using the material on the contract the company is able to avoid disposal costs. The procedure should only be used for short-term decisions, given that opportunity cost is a subjective measure and may be subject to rapid change.

Marking scheme

Marks (a) Opportunity cost concept : opportunity foregone, sacrifice, etc 1 Scarcity of resource 1 AB scenario used for illustration 1 Two alternatives mentioned, scrap or replacement use Opportunity cost $2 per kilo (b) Opportunity cost contrast with traditional approach Sunk/unavoidable costs ignored Example from scenario Any other valid comment (for example, on disposal costs) 1 each, maximum 2

1 1

1 1 1 2

Total 10


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SECTION B

6 OWN LABEL

(a)

X Y $/unit $/unit

Contribution 26 24 Direct labour hours/unit 2 1.5 Contribution per direct labour hour 13 16 Rank 2 1 Minimum 500 units 300 units Uses 1,000 hours 450 hours 1,450 hours Balance 675 units 800 units

1,350 hours 1,200 hours 2,550 hours Total production 1,175 units 1,100 units

(b) Firstly, the resources available after meeting the minimum contract must be calculated.

Then inequalities/equations can be calculated and plotted to determine the optimal use of the remaining resources:

Resource Used by contract Unused Equation Data points X Y Total X Y

DL 1,000 450 1,450 4,000 2x + 1.5y = 4,000 2,000 2,667A 2,000 1,500 1,450 7,500 4x + 5y = 7,500 1,875 1,500B 1,500 600 1,450 4,000 3x + 2y = 4,000 1,333 2,000

In addition to the above resource constraints, there are two demand constraints:

x = 1,300

y = 1,400

and an iso-contribution line:

Z = 26 + 24y (using $20,000 as a target contribution) give data points of x = 769 and y = 833

See graph for solution.

(i) The optimal production plan is 725 units of X and 925 units of Y plus fulfilment of the contract.

(ii) If the contract were not to be performed then the resources used by the contract would be used to make additional units of X and Y for sale in the external market.

The graph shows that the two material resources are more binding than the direct labour constraint so the optimal use of the resources released can be calculated:

4 + 5y = 3,500 becomes 12 + 15y = 10,500 and 3 + 2y = 2,100 becomes 12 + 8y = 8,400


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Therefore 7y = 2100 so y = 300 and by substitution x = (3,500 (5 300))/4 = 500. This is the same as the resource utilisation for the contract, so revenues can be compared.

All of the production capacity can be sold in the open market at the full selling prices, so if the penalty value were equal to the loss of sales revenue, the company would be indifferent between the contract and market sales. This amounts to:

500 Units of X at $13 per unit plus 300 units of Y at $12 per unit = $10,100

(iii) Both material constraints are binding. If material B were less scarce then the output would change:

Existing position: 4 + 5y = 7,500 becomes 12x + 15y = 22,500

3 + 2y = 4,000 becomes 12x + 8y = 16,000

Therefore 7y = 6,500 so y = 928.57 and by substitution = (7,500 (5 928.57))/4 = 714.29

Revised position: 4 + 5y = 7,500 becomes 12 + 15y = 22,500

3 + 2y = 4,001 becomes 12 + 8y = 16,004

Therefore 7y = 6,496 so y = 928 and by substitution = (7,500 (5 928))/4 = 715

Thus there is a reduction in y by 0.57 units losing $13.68 contribution. There is an increase in by 0.71 units gaining $18.46 contribution. The net effect therefore is an increase in contribution of $4.78 so the maximum price that should be paid per kg is $8.78 (the original cost per kg plus the contribution value).

Marking scheme Marks (a) Contribution per unit, 0.5 each Correct ranking Usage in hours Balance Total production F/T 0.5 each (b) (i) Resources available Demand constraints (b Iso-contribution line Graph Conclusion (ii) Say no contract = more Xs and Ys Optimal use of resources Y,x value Conclusion (iii) Calculate existing position Calculate revised position Y,x values Conclusion Total

1 1 1 1 1 2 1 1 6 1 1 1 2 1 1 1 1 1

25



0 500 1000 1500

X

7 BLACK AND BROWN

(a) We are asked for the group contribution and therefore the transfer price can be ignored, as it is a purely internal transaction. it is both a cost and a revenue within the group, and cancels out.

Blackalls Brownalls $ $ $ $

Selling price 45 54 Variable costs Processing costs 12 14 Alpha @ $6 18 12 Beta @ $4 8 16

(38) (42)

Contribution 7 12 No of units 200 300

1,400 3,600

Group contribution $5,000

3000

2500

2000

1000

500

0

Graph to show optimal production plan for December

DL

x demand

B

A y demand

ISO Contribution A B



(b) Decision making plays no part here. We are told how the transfer prices are set and we merely have to apply those transfer prices.

(i) Alpha Beta $ $

Transfer price 6 + 0.50: 4 + 2.75 6.50 6.75 Variable cost 6.00 4.00

Contribution per unit 0.50 2.75

The transfer price is variable cost + shadow price, we then take off the variable cost. Not surprisingly, we end up with the shadow price as the contribution.

(ii) Blackalls Brownalls $ $ $ $

Selling price 45 54 Variable costs Processing costs 12 14 Alpha @ $6.50 19.50 13 Beta @ $6.75 13.50 27

(45) (54)

Contribution per unit 0 0

Once we get good at transfer pricing, we could identify the scenario and apply the appropriate rule in a very short time indeed, and we would know the answer to part (b) instantly.

We have production constraints. There is a limited amount of Alpha and Beta available, which means that the selling division makes only one product which is only sold internally. This seems to be true of division A, which appears to make and sell alphas only. Similarly division B appears to make only one product betas, which it only sells internally. Therefore all the contribution appears in the selling divisions books.

(c) At the transfer price of marginal cost plus shadow price all the contribution of the group will be recorded in the supplying division. This transfer price is correct for decision-making purposes and achieving goal congruency. However, the transfer price is unsatisfactory from a performance evaluation viewpoint. Black and Brown Divisions will generate zero contribution. Hence, this system is unlikely to motivate the managers of these Divisions.

(d) (i) Division A

Although the capacities of divisions A and B have each doubled we are told that the market demand for Blackalls and Brownalls will still exceed the production availability. Therefore, there are production constraints. The rule is:

Optimum TP(DM) = Marginal cost + Shadow price = $6 + $0.30

= $6.30

(The $0.30 is 5% $6.)



Division B

This is a perfect market Beta can be bought and sold in unlimited amounts. The rule is:

Optimum TP(DM) = Market price Any small adjustments

= $7.50 $0.50

= $7.00

(ii) We now know the transfer prices that the selling divisions will charge. We just need to work out how the buying divisions will react and we will then be able to calculate the contribution for each division and then be able to add them up to get the group contribution.

Alpha Beta $ $

Transfer price 6.30 7.00 Variable cost 6.00 4.00

Contribution per unit 0.30 3.00 No of units 2,400 3,200

Contribution 720 9,600

Blackalls Brownalls $ $ $ $

Selling price 45 54 Variable costs Processing costs 12 14 Alpha @ $6.30 18.90 12.60 Beta @ $7 14 28

(44.90) (54.60)

Contribution per unit 0.10 (0.60)

No of units 800 80

We have calculated the contribution per unit for Blackalls and Brownalls and found that Brownalls give a negative contribution. We do not want to produce any Brownalls. Blackalls do give some contribution (a very small contribution, however).

We want to produce as many Blackalls as possible, but are constrained by the limited amount of alphas and betas available.

There are 2,400 alphas available. Each Blackall needs 3 alphas. We therefore have enough alphas to make 800 Blackalls (2,400/3).

There are 3,200 betas available. Each Blackall needs 2 betas. We therefore have enough betas to make 1,600 Blackalls (3,200/2).



The limit for Blackalls is therefore 800 units. There are enough betas to make 1,600 Blackalls, but we run out of alphas after making only 800 Blackalls. This is therefore the limit.

Group contribution = 720 + 9,600 + 80 + 0 = $10,400

Strictly speaking the plan shown for beta is not quite true, because only half the beta is used internally in order to make Blackalls. The other half would be sold externally and would earn the same contribution per unit and therefore the overall contribution is the same.

Marking scheme Marks

(a) Contribution Blackalls Contribution Brownalls Group contribution (F/T available) (b) (i) Contribution per unit Alpha Contribution per unit Beta (b (ii) Contribution Black Contribution Brown (c) TP supplying division all contribution TP correct for DM TP correct goal congruence TP not correct for PE Behaviour impact (d) (i) Division A constraints Division A TP calc Division A TP rule : MC and shadow price Division B no constraint Division B rule TP = market price Division B Calc (d) (ii) No Brownalls produced Alpha Limiting factor : 800 Blackalls Beta Limiting factor : 1600 Blackalls Group contribution Total

1.5 1.5 1

1.5 1.5 1 1 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1

25

cima - p2 final assessment - answers m14

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